By Christopher W. Brody, Ali Rahimtula
From time to time, we have been asked what characteristics successful Internet, or Internet enabled, companies have in common. In surveying existing successful companies, we came up with the list below. Please bear in mind that no company necessarily had all of these characteristics, but all successful companies had at least some of them.
Scalability and Strong Growth Potential
- A business must have the potential to grow revenue and gross margin at an attractive rate.
- The product is viral – preferably massively viral – as opposed to just word-of-mouth.
- The business is internationally transportable.
- The go-to-market plan enables the company to acquire a significant number of customers at a reasonable customer acquisition cost.
- The business has potential for horizontally scalability, i.e. the existing business processes are exportable to different verticals. Priceline is an example, which has expanded into hotel, air travel, rental car, and vacation package booking.
A Must Have Product
- Fills a compelling need – it is a “must-have,” not a “nice to have.”
- The decision to purchase is not deferrable – i.e. TurboTax , Uber, Airbnb, or, to a lesser extent, Open Table.
- It provides a user with tools to do something he can’t otherwise do (i.e. search).
Demonstrable Customer ROI
- The service or product will have a clear, tangible, value proposition. The purchaser knows precisely what they are getting and there is some immediacy to the payback.
- It offers substantially lower cost, and/or substantially greater convenience than legacy solutions.
- Ideally, the product or service has an ROI that be quantified and measured.
- The product has a high “value-to-friction” ratio. For example, using the product or populating templates to make it usable does not involve a lot of effort, and the ratio of value received relative to the energy required is high.
High Customer Engagement
- The business has high customer engagement. The more engaged users are, the more they visit a site or use the mobile application. If a service has high engagement, a large percentage of the users return to the site daily or weekly. Facebook is perhaps the best example of an Internet business with high customer engagement. As of September 2015, Facebook had 1.55 billion monthly active users and of these 1.01 billion used the site on a daily basis. Additionally, on average across the total user base, users spent 20 minutes per day on the site.
- To have high engagement, the service must either:
- Constantly update with valuable content so that the user/member wants to return to see what’s new (examples: Facebook, Twitter, or to a lesser degree, Tech Crunch or the New York Times).
- Be “mission critical” to the users life (examples: QuickBooks, WestLaw).
- All else equal, a business is more attractive if the frequency of need and time sensitivity of availability is high (examples: stock quotes, weather, flight tracker, sports scores, etc.).
- Leverages the interaction of commerce, community, and content.
- In an ideal world, a business would have both “valuable refreshing content” and play a “mission critical” role (e.g., the Bloomberg terminal for a securities trader).
Strong Network Effects
- The general idea is that a network effect occurs when the service becomes more valuable when more people use it (examples: fax machines, Facebook, WhatsApp, Snapchat, LinkedIn, Microsoft Office). If a service has high engagement (from valuable refreshing content), the user community is eager to send viral invitations to get more members involved.
- The business has the ability to win the minds, as well as the hearts of the user. Brands that have a strong conviction around why they exist will end up attracting more loyal customers. An emotional attachment to using the product (which can be fun or generate loyalty) offers subliminal “permission” to be integrated with a “network of products” effect to go along with the “network of users” effect.
High Customer Persistency / Low Churn
- A product that is sufficiently “sticky” that customers are likely to use it for a long period of time, and less likely to switch to a competitive offering or churn off for other reasons. Churn is hard to properly assess for very young businesses but for businesses with greater than one year of customer revenue the data is revealing. The best businesses will ultimately generate negative churn on a dollar basis, which means that the impact of customer upsells (adding seats or buying more modules) will outweigh the impact of churned customers.
- As mentioned previously, a product whose periodic use is not deferrable will tend to have a longer user life.
- Additionally, to the extent that customers have to populate the product with their own data, this tends to increase the friction (even if just psychological) of moving to a competing product (e.g. Salesforce.com, QuickBooks, Evernote, Dropbox). This will extend user life as well.
Attractive Unit Economics
- Customer acquisition costs should be roughly equivalent to the gross margin on the first year of a customer’s revenue. The gross margin on the lifetime customer revenue should vastly exceed the customer acquisition costs.
- Gross margins should be positive and trending higher (ideally approaching ~80% or more for an Internet business).
Compelling Business Model
- A subscription model that provides consistent recurring and predictable income is attractive, especially if it has potential future upgrade possibilities.
- A business that has the potential to become a platform can be especially valuable. A platform allows other companies to offer their products thereby creating potential incremental income for the basic site, while enhancing its value in convenience to its users.
- For certain businesses, it can be an advantage if someone else will pay for the product – such as advertisers who enable a site to be free to the user (with a minimum of irritation from ads). Google search is a prime example of this.
- Has a realistic and attractive business model (not a: “if we build it they will come, and then we’ll figure out how to monetize it”).
- Business is capital efficient with modest cash burn and has a plan to achieve profitability within a reasonable time frame.
Large Addressable Market
- The business must address a sizable market.
- To the extent the business has the potential to expand into adjacent markets (i.e. can expand internationally or into horizontal markets), this can make the business more attractive.
- Absence of significant direct competitors or the ability to create a competitive moat for its product.
- The technology is scalable, i.e. has the ability to add significant number of users / volume without running into stability issues or requiring dramatic re-engineering.
- Technology is agnostic in the sense that there is nothing about it which would inhibit a third-party from adding onto it, and thereby enhancing its value to the user.
- Technology trusted and secure.
- Technology has intellectual property protections and also requires significant lead-time to replicate.
Entrepreneurs may ask if their business needs to exhibit all of the foregoing characteristics to be successful, to which the answer is an emphatic no. However, to the extent a business does have many of these characteristics, it is more likely to be valuable.
Note: painting by Mariolo Wloch.
Copyright 2015 Ali Rahimtula. All rights reserved.